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Earlier this year I failed to sell Baremetrics for $5m. But I learned a heaping pile of things from that and one of the biggest things I learned about was the world of asset sales and stock sales.
This is about to get real nerdy but this is crucial if you’re trying to sell a company. It could literally save you millions of dollars.
I’m in no way an expert on taxation, but I did pick up a few knowledge nuggets throughout this process. This largely (and maybe exclusively) applies to US-based companies, so keep that in mind.
What’s an asset sale and what’s a stock sale?
Depending on how your company is set up, you’ll have the option to do an asset sale or a stock sale.
In an asset sale, you’re selling the assets of the company as opposed to the company itself. Typically the buyer will set up their own entity to purchase the assets from your entity (which is generally something like an LLC, S-Corp or C-Corp). This leaves the actual entity in place for you to shut down or do what you will with.
In a stock sale, you’re selling stock that the company has issued and generally you’re selling the majority of the stock such that the buyer controls the company thanks to their majority share. You’re basically selling off ownership of the company.
There’s definitely a lot of nuance there that I’m leaving out, but that’s the high-level. And what I want to focus largely on is the tax burden differential between an asset sale and a stock sale the revolves around something called Qualified Small Business Stock (QSBS).
But I’m getting ahead of myself. We need to layout some real world numbers.
How an asset sale plays out
In an asset sale, you pay an obscene amount in taxes as the company is subject to corporate tax while you’re subject to personal tax. Meaning the purchase amount is effectively double taxed.
I’ll oversimplify it a bit, but let’s take a $5m offer.
As an asset sale it’d first get hit with 27.5% at the corporate tax rate. That’s $1,375,000 that comes right off the top and straight to the government. That leaves $3,625,000.
Then, say that all went to me (which it wouldn’t), that amount would then be subject to 44% in federal, state and payroll income tax. That then brings the final amount down to $2,148,900.
Uncle Freaking Sam just ate $2.8m of your company. And that doesn’t even include investor payouts, legal fees, stock option payouts, etc.
The reality is, in a $5m asset sale, I’d have walked away with $1.4m. Yay money, but nowhere near as cool or interesting as the original $5m sounded.
Needless to say, an asset sale was off the table for me. Which brings us to a stock sale.
How a stock sale plays out
The reason a stock sale is infinitely more interesting than an asset sale is thanks to QSBS, which I mentioned earlier.
At the risk of drastically dumbing this down, QSBS allows anyone who has held C-Corp stock for over 5 years to sell it tax free.
Sweet beard of Zeus. Yes, tax. freaking. free.
The massive caveats there are that it must be a C-Corp and you must have held the stock for at least 5 years. There are a lot of other caveats there as well, but in my particular case, I qualified for it.
So, if we go back to my $5m example from earlier, instead of losing 57% of the purchase price to taxes, I’d only pay 5%.
That 5% goes to the State of Alabama because our state government doesn’t “recognize” QSBS because we’re stuck in the dark ages and prefer being the last state to make any improvements.
After all the other fees (investors, legal, stock options, etc), in a $5m stock sale, I’d have taken home $3.5m. Simply changing the type of sale more than doubled what I’d take home.
I had no idea about any of this back in April. It blows my mind that there’s such a massive difference between an asset and a stock sale, but it’s literally life changing.
To reiterate, QSBS only applies to C-Corp stock. So if you’re an LLC or an S-Corp, it does not apply.
I’m not sure if there are any similar mechanisms in place for those types of entities. But suffice to say, the US government will do everything in its power to take as much of the sale of your company as it possibly can and you should chat with a tax attorney to figure out how to mitigate their greedy paws.
Hopefully that’s helpful, if not a bit oversimplified. It’s definitely worth talking to your CPA or a tax attorney to see if you qualify (or how to set your business up in such a way that you’d qualify). The 5-year runway means you’d want to go ahead and get things set up now if you think there’s a chance for a big sale down the road.
